Latin banks open purse-strings to upgrade anti-laundering systems

Latin and Caribbean banks are investing heavily to make up lost ground in putting together water-tight anti-money laundering (AML) systems. They are being driven by much more stringent international and domestic regulations, a closer eye from their north American counterparties and greater attention from and a bigger choice of external providers of AML systems. Banks in the region are busy building up compliance and ML teams as well as beefing up systems that harmonise their AML policies across jurisdictions and business lines.

The issue has moved centre stage in the last two years. At the end of last year, 24% of Latin banks said it had been the biggest priority that year, with 17% predicting it as the biggest priority for 2006, according to a poll of more than 100 bankers taken at the annual assembly of the Latin bank association in Miami. Progress has been made: some 90% of banks in the region have implemented systems to combat laundering and, of those that have not done so, 80% said they were planning to implement systems this year.

Even though the poll suggests most of the hard work has been done, some banks, particularly smaller ones, continue to take a bare bones approach to regulations, implementing just enough to escape sanctions. They have been helped by some of the regulators who are abiding by the letter of the law but not the spirit. Robert Mercer of business software firm SAS recounts some of his experiences as a vendor of AML software in the Caribbean region. As the director general of the firms Latin America and Caribbean regions he is in a good position to know that: A small number of the banks have become addicted to laundering. If they were to clean up, it would hurt them a lot.

Whats Been Achieved
Overall, Latin America deserves a pat on the back. On a top-down look, the provisions of the Patriot Act and Basel II have filtered down and there are no longer any Latin countries on the Financial Action Task Forces Non-Cooperative Countries or Territories list. Thats a remarkable change from 2000 when Panama; the Cayman Islands; the Bahamas; St Vincent and the Grenadines; and St. Kitts and Nevis were all listed. Guatemala, which was added to the list later, was taken off in 2004 making Latin America and the Caribbean a fully compliant zone.

The Caribbean has greatly tightened practices and has much higher standards than on-shore business, reckons Cayman Islands-based Anna McLean, Regional Head of Compliance, at FirstCaribbean International Bank (see also case study). She points out that to open an account in the region, you need not only an ID, but references and a letter from your employer.

She acknowledges that the Bahamas and her own Cayman Islands did have problems: There were a number of shady dealings going on. These were particularly concentrated in small, privately-owned banks. That said, the tightening of regulations and redoubled scrutiny has seen many of them close or get their act together.

The two largest economies, Brazil and Mexico, are making headway year-on-year. Brazil set up the Brasilia-based COAF (Conselho de Controle de Atividades Financeiras), a central body to collect and report data, which is embedded in the Ministry of Finance and to whom banks must report all unusual transactions. The country is implementing equally tough legislation for insurers at the end of the year that covers brokers and calls for full staff training by banks and insurers. And regulators have been carrying out extensive checks at banks. They started with the largest and are now looking at mid-sized and small banks. Inspectors spent seven weeks checking everything at the bank. It was really thorough and surprised everyone, recounts one source.

Mexico too has made significant progress. The country has been moving to risk-based supervision and regulators have been given more autonomy. The government has been tightening up on laws covering terrorist financing and freezing and seizing assets as well as looking at laws on financial secrecy, areas that were raised in the 2003-04 AML assessment. Every year, the Mexican authorities are tightening up legislation, says Xavier Ramos, corporate director of systems at Grupo Financiero Monex, a large financial intermediary, broker and money manager.

From a bottom-up perspective, large and mid-sized banks, especially those that carry out many transactions with the United States, have responded most rapidly to these changes and to business logic. Increasingly, banks in the US refuse to continue doing business with those Latin banks which process transactions without carrying out due diligence on customers or the transaction, says Ramos. Thats vital for Mexico where banks are particularly dependent on US transactions. Monex handles some 6,000-7,000 payments per day and nearly 80% of those come from the US so retaining good relations with those US banks is key.

Ramos believes that sooner or later, all banks in Mexico that havent yet done so will need to strengthen AML systems. Those that are doing it piecemeal will soon find that they dont have the resources and will need to implement expensive external solutions. Its better to pre-empt the extra legislation by spending the money now, he says.

Banks face up to reality
The recognition that building AML systems is necessary has become more firmly rooted in the region. A recent Kroll survey of Latin banks found that 50% believed they should spend between 1-5% of income on AML, 24% believed 6-10% was appropriate and 26% believed they should spend more than 10%.

That said, often the hardest and longest part of the AML process is building a business case and extracting a meaningful budget. FirstCaribbeans McLean was brought on to look at systems as the bank grew. The first stage in looking at new systems has been building the business case. The discussion has been won through emphasising the importance of protecting the banks reputation: We needed to ensure that our reputation was a primary asset.

At budget time, AML can land up at the bottom of the pile. Its just not something whose value is easy to quantify, adds Ramos. Latin banks can be particularly sensitive to pricing, Fortunately, a strong background for banking profitability, particularly in Brazil, has helped compliance officers to get the budgets for AML systems approved.

Its not just a question of setting the budget. Latin banks often find that the figure that they had in mind needs to be increased. We expected it to be cheaper, but once you start on this kind of project, things just start to add up, Ramos cautions. The total budget for Monex for AML hard and software has been a little over $6 million in the last four years. Once a business case has been made and management have agreed to implement an AML system, the next decision is whether to build the system in-house or rely on external vendors.

In general, the large Brazilian banks that were the first to implement comprehensive AML systems opted to build them in-house, says Marcia Klinke, a director in the forensics department of KPMG in São Paulo. Partly, that was because there were fewer vendors in the region but also because these banks were so large and complex that a one-size-fits-all solution was not workable and they tended to have in-house resources to build these systems.

Brazils largest bank, the Banco do Brasil is one example. The bank did consider using outside vendors. However, an external system would have been extremely time consuming and the necessary customisation more costly to implement because of the banks vast size. It has 84,000 employees and processes 600 thousand transactions per month, says Edson Lobo, executive director, security in Brasilia. Lobo was in a position to capitalise on the extensive IT resources in-house. The system took just one year to put into place and Lobo insisted that it be flexible, easy to update and able to alter criteria. Initially, it did need some tweaking to provide the correct sensitivity in picking out unusual transactions but is now working well. Not surprisingly, Banco do Brasil is closely scrutinised by regulators particularly its compliance department.

The propensity to use an in-house system may be changing in Brazil as it has in more developed countries, believes Klinke. Providers initially had to customize their programmes vis-à-vis Brazilian banking products and regulations, Brazils currency and financial transactions tax, the CPMF, and this caused early projects to be time consuming. More standard programmes have been developed that take into account the regions peculiarities, she says. A further incentive for banks to look to outside providers is the need to update systems constantly to keep abreast of new regulations and the changing nature of money laundering. The first signs that this is becoming more prevalent are already there. Already the use of services that consolidate multiple suspicious person databases, such as World-Check, are becoming common.

There are other reasons that banks are choosing to consider external vendors. Outside providers maintain and update their systems constantly and because this is their core business, they should be better at ensuring the systems are well-maintained, says Klinke. And there is simply more choice of external packages now than there was.

Banks that have grown rapidly through jurisdictions or business lines, such as Monex or FirstCaribbean International, seem to prefer outside providers. The AML package is often part of a larger IT-deal that simplifies systems. Ramos explains that Monex, which had been growing rapidly through acquisitions, was left with a large number of incompatible legacy systems, the integration of which would have been highly complex. Furthermore, in the late 1990s customers started to demand that their different lines of business  equities, bonds, foreign exchange  were all handled within one umbrella account.

This led to the decision to look for a system that could handle all the banks lines of business using only one database. The AML component was an integral part of that choice and when it came to choosing between providers, Monex wanted a system with which its US counterparts were familiar. The first question that the compliance departments in the US ask us is: What system do you use? If its a system that they know and recognise, they are much more trusting. The company shopped around for the system in 2001 and it took a further two years to choose and implement.

Regulations Lag Behind
As national legislation has been tightened and banks have put systems in place, the number of unusual transaction reporting has soared. And yet, weak and slow judicial systems throughout the region mean that there are few successful prosecutions and even less success in identifying and repatriating assets. Increasingly, banks are finding this frustrating.

Brazil, the largest economy in the region, is a good example. The country has been successful in drafting international AML norms and getting banks and other institutions to comply with them. The difficulties start when transactions are confirmed as suspicious and cases start to wend their way through the Byzantine judicial system.

Lobo sees the judicial system as the weakest link. The structure of the system needs to be improved substantially. Difficulties include the long time taken to reach trial, which can undo all the good work undertaken by banks to report transactions, he says. And the system is particularly weak in asset recovery taking so much time to identify, freeze and seize assets that in most cases they have been moved elsewhere.

KPMGs Klinke agrees that Brazilian attempts to tackle money laundering could be more successful should the judicial system not be subject to multiple layers of appeals. However, progress is being made. The government has implemented a fast-track, specialised court system to tackle money laundering, white collar crimes and crimes committed by organized crime groups, the first of its kind in the world. In addition, the federal police has seen its financial and technical resources improved and an asset recovery department has been implanted in the Ministry of Finance, leading to the freezing of some $300 million of assets deposited abroad. These are all positive signs although it is still too early to measure the systems success.

It has proved very difficult to recover assets from overseas jurisdictions. Brazil is now signing a series of bilateral and multilateral agreements with other national governments to accelerate the process of tracing, freezing and repatriating resources derived from crimes, specially corruption by public officials. In cases where no such agreements have been signed requests for repatriation of money have to be carried out through letters rogatory which are often ignored or are processed so slowly that all the assets have been removed and there is nothing left to repatriate.

FIRSTCARRIBEAN: CASE STUDY
FirstCaribbean International hired Anna McLean a year ago to oversee updating systems in the compliance area. She was in an ideal position to take a macro view as the ex-head of banking supervision at the Cayman Islands Monetary Authority, where she had worked on bringing the islands up to date with international initiatives, including work to have the islands removed from the Non-Cooperative Countries or Territories list.

When she arrived, she found a bank in transition. FirstCaribbean had grown from retail roots and has become steadily more complicated opening more business lines and spreading through the English-speaking Caribbean, explains McLean. It was getting involved in wealth management, buying ABN AMROs wealth management operations in Curacao in 2005; developing in capital markets, opening its latest hub in the Bahamas in the same year; and enhancing its insurance business as well as pushing into new jurisdictions.

A further twist was the banks planned change in ownership structure. In June, Canadas CIBC and Barclays Bank reached a definitive agreement for the former to acquire Barclays 43.7% ownership stake in FirstCaribbean for US$1.08 billion, subject to regulatory approval. Before we had two banks to turn to for guidance, we werent standing alone. Now that were set to be totally independent of Barclays, we wanted to make sure that we had the systems in-house.

The bank needed to upgrade its risk management and AML systems across all the lines of business, taking into account the diverse risk profiles of each. The retail roots mean that the bank was used to monitoring very large amounts of cash deposits. The challenge was to ensure that the same exacting standards applied across all the banks businesses in its 17 jurisdictions.

FirstCaribbean started by significantly expanding its staff and is now looking externally for a new and more comprehensive tool for scanning for unusual transactions, says McLean. The system will need to automate many of the processes that are currently handled manually. We have a very comprehensive system in place but it relies on a proactive stance instigated by the compliance team. We wanted to take out the human element.

The new system will also need to catch small but complex laundering: the current system is not spotting small transactions that are carried out through multiple branches and this hole needs to be plugged, notes McLean. The other prerequisite is that the system applies a common threshold across businesses and jurisdictions.

The bank has looked at a number of vendors, including Brookfield, Wisconsin-based Fiserv and Herndon, Va-based Mantas, and Verafin which is based in Mount Pearl, in Canadas Newfoundland and Labrador province. The decision is made complicated as the systems all vary somewhat so youre not comparing apples to apples, she says. Most of the quotes have come in a range of $200,000-400,000, she notes. McLean is sceptical, despite the vendors claims, that they will be able to deliver a comprehensive package covering all of the banks needs. The bank has not yet reached any definitive conclusion and might consider other vendors, notes McLean, adding that she expects to pick the vendor at the end of January next year.

FirstCaribbean International Bank is the largest, regionally-listed bank in the English-speaking Caribbean, with assets of over US$9.5 billion and a market capitalization of US$3.3 billion. The Bank has over 3,500 staff; 100 branches and banking centres, and offices in 17 territories, serving 800,000 active accounts.